The Evidence-Based Investorhttp://www.evidenceinvestor.co.uk
Buffett and Bogle are right — the best way to invest is to buy and hold a low-cost and highly diversified portfolio of assets for a very long time.Mon, 19 Feb 2018 19:06:43 +0000en-UShourly1https://wordpress.org/?v=4.9.4123791526Many investors think they have a market edge. Very few dohttp://www.evidenceinvestor.co.uk/many-investors-think-edge/
http://www.evidenceinvestor.co.uk/many-investors-think-edge/#respondMon, 19 Feb 2018 18:26:50 +0000http://www.evidenceinvestor.co.uk/?p=6453The most important question investors need to ask themselves, says Lars Kroijer, is whether they have a market edge. If you don’t, he says, you shouldn’t be trying to beat the market — or paying anyone else to try to beat it in your behalf. Here he explains how it’s very unlikely that you do […]

]]>The most important question investors need to ask themselves, says Lars Kroijer, is whether they have a market edge. If you don’t, he says, you shouldn’t be trying to beat the market — or paying anyone else to try to beat it in your behalf. Here he explains how it’s very unlikely that you do have an edge.

This is Part 2 of a three-part series. Last week Lars gave us his opinions on how to respond to stock market volatility. We’ll be publishing Part 3 next week.

In your book, Investing Demystified, you counsel against people trying to manage their own investment portfolio. Why do you feel so strongly about that?

There’s one certain way to lose a lot of money, and that is to trade a lot. You’re sure to lose, so don’t do it. I hear stories of people who day-trade futures on the markets; it’s a miracle to me that those people stay in business.

I look at general retail investors and see people trading on the basis of not very much information, and not very good information. They certainly don’t have an edge over the market. Not only that, it also takes a ton of time. They get up and devour all the financial websites, chat rooms and financial pages. Sometimes they haven’t read the annual report, and they certainly don’t have access too professional research. So not only are they at a huge financial disadvantage, with all the costs of trading, and the lack of information and robust analysis, but they also have a day job. To me it seems incredibly naïve to think that you can sit there in your boxer shorts on a Saturday morning and outperform the markets. There’s overwhelming academic evidence that you can’t.

So that’s what you’re up against. You have to think that you can beat the market to play the game. You also have to think that it’s worth your time. This is something people fail to understand. Let’s say you have a portfolio of £100,000. On the one hand you can buy an index tracker, and let’s say, historically, the markets have gone up 4% a year above inflation. On the other hand you can say, I’m going to do better than the market. What you’re getting paid for your time is only what you outperform the markets by, after all your costs and expenses. You can get the market pretty much for free by going to Vanguard, iShares or any other index fund provider. You’ve got to price your time. A lot of people forget to do that. OK, some people see it as a hobby, or, I don’t know, they do it instead of going to a casino. I would just argue that most people would be far better off if they just stayed away.

I get emails daily from readers and people who’ve watched my YouTube videos, and a surprisingly large proportion of the comments are about the joy of not having to read the financial news every day. They don’t have to read every new article about Google because Google is now only 1% of their overall exposure. This is a huge side benefit to indexing that is often not appreciated enough.

OK, so if an investor doesn’t have a market edge (and that’s most of us), they shouldn’t buy and sell stocks themselves. But what about paying active fund managers, who might have a market edge, to try to beat the market for you?

Well, you’ve got to take a step back and ask, what do the statistics say? The statistics say that over a ten-year period, one or two managers in ten will outperform their benchmark index. What does that mean? That means that if you’re looking at a smorgasbord of hundreds of active managers, 10 to 15% of those will outperform the market over a ten-year period. Can you pick those winning active managers ahead of time. Almost certainly no. The ones that have done best in the past statistically don’t do better in the future. And remember, it might look as though all the funds are still standing after ten years, but many have died because they underperformed.

So, you shouldn’t manage your own money and you shouldn’t use an active manager — in both cases because, before the fact, you can’t predict who the winners are going to be. So there’s a very compelling argument for accepting that you cannot beat the market and should instead buy an index tracker.

An important theme in your book is the cost of using active funds. What costs do investors incur, over and above the annual management charge?

Imagine you have two people and they both have £100 to manage. One buys a tracker fund, and the other buys an actively managed fund. An active manager is someone wearing an expensive suit who gets paid a lot to pick stocks, who goes and sees all these businesses, and talks to management. They have a whole team around them. And when they’ve done their analysis they’ll go into the market and buy shares, often frequently. And when they do that they incur commission. They also incur the price impact of the stock; in other words, some of these stocks are illiquid and they move the price by buying or selling it a lot. And then there are audit fees and accounting fees. And whenever you see a big billboard advert for a fund, that’s paid for indirectly with the fees you pay. So it’s not just the headline number. There are all sorts of other fees which the manager incurs managing your money. Now those fees are much higher for active managers than they are for passive managers.

Another problem is that you don’t know how often your fund manager is going to trade in any particular year.

Yes, it varies a lot from manager to manager. They’ll often give you a good idea, but you have to get into quite detailed knowledge of the fund manager to figure it out. Even then, it’s not entirely precise because they obviously want some leeway to act in the market as they see best.

You were, yourself, a hedge fund manager. Hedge funds seem to be suffering an identity crisis. What are they actually for?

Oh, I wish they knew! Hedge funds are investment funds. They’re essentially offshore vehicles that hedge movements in the markets. There are many different types of hedge fund. There about 10 to 12,000 of them in the world today, and they do all sorts of stuff. Some will do long-short equity, which means they might be long Facebook and short Google, and therefore the returns you make from investing in that fund is not dependent on the market; that’s a market-neutral hedge fund. Others might be long French government bonds and short German government bonds. So there are many different types of hedge fund. But the overriding theme is that they’re very expensive to buy, and very often the return profile that you get from them is not like that of the market.

So, is there ever a case for using hedge funds?

I think hedge funds can be a great investment, but they’re often not! The premise of hedge funds can be great. Say you could invest in ten hedge funds, and let’s say that you expect the return from each of them to be 10%. Let’s further say that none of them is correlated to the market, or to each other. Having a return of 10% a year, regardless of what happens in the markets, would be the nirvana of investing, but the reality has not been like that. When 2008 hit, hedge funds did worse, just like everyone else, so returns are not as uncorrelated as they at first seem. And of course there’s an asymmetry that if a hedge fund does really well, because of the performance fee that they earn, they get paid a lot. When they don’t do well, they don’t give the money back — or most of them don’t give the money back. So that’s an asymmetry that’s costly for the investor over time.

In the book, you also stress the importance of diversification. Why is lack of diversification such a problem?

The obvious example is the global financial crisis. Why did the subprime market go pear-shaped? There were were lots of reasons, but one of them was this perception that the US housing market couldn’t all decline at once, because the Miami, Denver, LA and Las Vegas markets, for example, were uncorrelated. It turned out they were not. How did people get hurt by that? They said, I’m going to buy an awful lot of these bonds that indirectly have exposure to the US housing market, because it’s a diversified investment, when really it was not. So that’s a case of people thinking they’rediversifying, but they’re not, and as a result they put much too much into a concentrated portfolio, and it all goes pear-shaped all at once.

Another example I like to give is this. Imagine you’re an insurance salesman in Florida and you insure oceanfront condos against hurricanes. You get the premiums and with them you invest in oceanfront condos. That would be the worst thing you could possibly do. Why is that? It might go well, and there may be no storms, so not only do you not pay out for insurance, but the investments also go well. But if it goes poorly, it’ll go terribly poorly all at once and for the same reason. That’s the kind of thinking people don’t do enough of in their own private lives.

Something else you strongly warn against in the book is being too heavily concentrated in one particular geographical region.

Yes, there are lots of examples of where local stock markets go bust when there are problems in the local economy. Latin America and Asia have a lot of examples like that.

The Japanese stock market was a great example. I remember when I went to university, all we could do was talk about the Japanese market, and the “miracle”, and how Japanese production techniques were going to dominate into the future. This was in the early- to mid-1990s. Since then the Japanese market is down 75%. And this is now 25 years later. If you look at that from the perspective of Japanese investors — which incidentally is an interesting case of people who don’t look outside their own universe of opportunity — wouldn’t it have been great to have been in that small number of investors who diversified internationally? If you look at the local banks, the local real estate market, local insurance companies and people’s local savings, they all went down at the same time and for the same reason, namely the Japanese economy. The ones who had diversified globally would actually have been part of a rising market.

Next time: In the third and final part of this series, Lars Kroijer discusses property investing, cryptocurrencies and the financial media. He also explains the value of using a financial adviser.

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]]>http://www.evidenceinvestor.co.uk/many-investors-think-edge/feed/06453Charles Payne: Lessons learned from 35 years in the fund industryhttp://www.evidenceinvestor.co.uk/charles-payne-lessons-learned-35-years-fund-industry/
http://www.evidenceinvestor.co.uk/charles-payne-lessons-learned-35-years-fund-industry/#respondThu, 15 Feb 2018 11:42:46 +0000http://www.evidenceinvestor.co.uk/?p=6441This is fascinating. It’s an interview with Charles Payne, a long-standing TEBI reader, who recently left the UK fund industry, having worked in it 35 years. In that time he’s worked for some of the biggest institutions in the City of London — Henderson, Gartmore, UBS Asset Management, Kleinwort Benson, Chase Manhattan Bank — but […]

]]>This is fascinating. It’s an interview with Charles Payne, a long-standing TEBI reader, who recently left the UK fund industry, having worked in it 35 years. In that time he’s worked for some of the biggest institutions in the City of London — Henderson, Gartmore, UBS Asset Management, Kleinwort Benson, Chase Manhattan Bank — but he’s probably best known for the 14 years he spent at Fidelity International, where, among other things, he served as Investment Director and Head of Equity Product Management.

In the interview I ask Charles Payne about his experiences of the industry, the FCA report on competition in asset management, the arrival of MiFID II, the future of active management and, finally, corporate ethics and culture in the City. Everyone who wants to understand the fund industry should read what he has to say.

I present the interview with no comment whatsoever from me, but I’d be very interested to hear other people’s views.

Charles, you’ve worked in the UK fund industry since 1982 and rose to director level at Fidelity, one of the biggest names in global asset management. How would you summarise your career and what you learned?

At the start of my career asset management was very much the Cinderella of the finance industry. Big Bang established sell-side brokers as the Masters of the Universe, as Tom Wolfe brilliantly captured in Bonfire of the Vanities; they controlled all access to the market and if you wanted to buy and sell anything, the only way you could do it was via them. Slowly during the late 1990s and 2000s there was a discernible shift in power towards the asset management industry as they realised that it was they who controlled the flow of assets to the market, and that brokers could not function without the capital they controlled. It is no coincidence that this was the period when we first started to become aware of ‘star’ fund managers who up till that point had been able to quietly go about their work in almost total obscurity.

The investment industry has enjoyed this shift in the balance of power slightly too much, however, and so have been late to realise that, since 2008, asset owners have woken up to the fact that the assets were theirs all along. This realisation is in part, I think, due to the transition of pension arrangements from DB to DC; as a DB scheme member the amount the external manager charged didn’t impact your pension in any direct way at all. However as a DC member it does in an extremely real way.

My experience of talking to people who work, or used to work, in UK asset management, is that there’s a general awareness now that things have to change, that the industry needs to be more transparent and add more value. Is that your experience too?

Clearly yes. The NYU Stern analysis of business margins divides the economy into 93 industries and calculates gross and net margins for each. In January 2018 their Investment and Asset Management category had the seventh highest net margin at 22% — three times more than the rest of economy excluding all the financial sectors. Somehow we seem to have forgotten that financial services are there to provide services to the rest of the economy, not be the economy.

To be fair, this isn’t an observation limited to asset management; the five main financial sub-sectors all appear in the top seven highest-net-margin industries. If you live your life in the financial echo-chamber then what you are charging doesn’t appear excessive compared to other parts of the financial industry; but when viewed from the perspective of the rest of the economy, sustained margin pressure is inevitable. So the next ten years have to be about asset owners demanding better products with better sharing of returns at lower costs with greater transparency — of that there can be no doubt.

What did you make of the FCA report on competition in UK asset management? The interim report, in particular, was very critical. Did that come as a surprise to you?

Having worked at a number of large houses, I have to say it didn’t, no. In legal competition-speak, I don’t think there is an obvious cartel at work per se in the asset management industry. What there is however is a generally accepted set of practices whereby client and manager interests are not clearly aligned, and which are underpinned by the spurious assumption that it costs twice as much to run £500 million as it does £250 million. What the new disrupters have done is to fundamentally challenge these accepted norms, accept that this will result in lower margins, and build corporate models that can thrive in such an environment.

While Vanguard may appear to be the biggest current threat to the large incumbents, I actually think that Ant Financial represents the clearest view of what the new disrupters will look like. It’s a strange paradox that the current industry dominators view the inexorable increase in regulation as being a threat to their business model; in fact I think it constitutes the largest barrier to entry, and that it has to date been the most significant single factor stopping the likes of PayPal, Amazon and eBay from storming the barricades. However, in the long term, it is hard to see this barrier as anything but temporary, and Ant Financial as anything other than the first of many such disrupters.

Now, of course, since the introduction of MiFID II, fund managers have to explain in full exactly how much customers are paying by law. Even still, many fund houses are still withholding information. What’s your view on that?

I think there are two problems here: how to calculate the total costs the client experiences, and whether to publicise them. To be fair on the first point, the regulations suffer from the usual problem of trying to describe mathematics in legal language. This seldom works as anyone who has tried to describe a performance fee calculation in English knows well. It is clear from looking at the numbers that have been published in the first six weeks since MiFID II came into being that different firms are doing it in different ways, but I am confident that with time a more consistent and level playing field with regards to calculation will emerge.

What is more disappointing is that a number of firms are taking the “day 1” position that they only have to disclose the MiFID total costs to existing clients, not publicly, as evidenced by a recent piece of Financial Times investigative journalism. The legal basis for this will undoubtedly be challenged, not least by Gina Miller in her latest letter to the FCA.

However, irrespective of the legal position, the only acceptable response from both an ethical and commercial point of view is to tell your clients the true total costs of what you are selling them in an industry-standard way. Even if you don’t accept the ethical imperative to do so, the commercial argument is to my mind clear — clients are far from stupid, and faced with a decision between two suppliers, they will be significantly more likely to buy the one that discloses its full costs compared with one that doesn’t.

I notice you lecture in business ethics, as well as asset management, at different business schools. What sparked your interest in the subject?

Gillian Tett of the FT writes particularly well about investment, not because she is a finance expert, but because she was formerly an academic anthropologist, and as such is well placed to take an objective view of the belief systems, ethical codes, herding instincts and behavioural patterns of those who work in it. Having studied anthropology as well this always resonated with me. If you work in a “bubble” with people from a similar academic and social background as you, you run the risk of living in an ‘echo chamber’ where everyone reinforces the continuation of the status quo and prevalent business ethics.

Being a fund manager is genuinely hard, not so much technically, but from a behavioural perspective. We require them to have conviction, take decisions, and have the courage to stand alone when they have a view that isn’t shared by the rest of the market. It is unsurprising then that when they are right, there is an all-too-human temptation to become arrogant and believe their own infallibility; equally when things aren’t going well, the pressure on personal ethics to avoid losing face is undeniable.

You can run as many quant screens on funds as you like; I still put more faith a manager who has the time to say hello in the corridor, and from whose demeanour you wouldn’t know if they are 500bps ahead of, or 500bps behind, the market. And perhaps asset managers should consider employing someone like the slave at victory parades in Ancient Rome, whose sole job was to keep whispering in the triumphant general’s ear, “Remember you are mortal”.

There’s been plenty of discussion about business ethics and the general working culture in the City of London, particularly since the global financial crisis. In your view, should we be concerned about it?

I am disappointed to say that yes, we should be. Ethics are a complicated and individual issue; Maynard Keynes is reputed to have said that “capitalism itself is the astounding belief that the most wickedest of men will do the most wickedest of things for the greatest good of everyone”. To my mind the overarching problem is that we have outsourced our personal ethics to primary regulation and the compliance department. As an industry we have fallen into the trap of believing that if regulations don’t specifically prohibit us from acting in a certain way, then we can do so with impunity. And as will happen when you have a lot of very clever people poring over legislation for loopholes, they will inevitably find some and take full advantage of them, so the regulators always risk being one step behind the practitioners. If this is the way you view regulation and ethics, then you cannot be surprised that, to the person on the top of the Clapham omnibus (otherwise known as your client), the finance industry periodically looks morally bankrupt, even though legally it is rare that miscreants can be brought to book.

The MiFID II disclosures run the risk of being the latest in this line of ethical outsourcing. Just because you believe that you can interpret the rules as saying you don’t have to openly publish your total client cost figures, pause for a moment and think about just how badly it will look to your potential and actual clients if you don’t. It is, after all, their money. Regulation should be there as the final safety net when personal ethics fail, not a wholesale replacement for them.

Finally, you presumably had a well-paid job in asset management. Are there ever times when you regret leaving all that behind?

As an archaeologist, Robin, I have probably excavated too many skeletons to believe that you get a second go at this, so 35 years in the industry was probably enough! I have been lucky enough to have a privileged view of an industry during a fascinating period in its evolution, to work with a gratifyingly large number of colleagues with intelligence, humour and strong personal values, and of course to be paid well for doing so.

It is a bitter sweet feeling – I miss having the opportunity to help the industry find a better model, a better dialogue with its clients and a better raison d’être. Equally I too was a part of that “echo chamber”, and it is only when you step outside of it that your mind gets the perspective it needs to get a clearer sense of the bigger dynamics and drivers of the whole ecosystem that investment management forms part of.

The key thing is – I am lucky enough to keep learning. I lecture at several business schools, where I am sure I learn more from the Millennial generation than they do from me. I work with a small but fascinating list of investment boutiques whose ethos and abilities I admire and who are generous enough to think I can help them on some of the issues discussed above; and as volunteer Chair of Finance and Resources at my local state secondary school I now understand what financial pressure in the real world feels like!

As the first of my family to go to university and the first to work in the City, 35 years ago I decided that I would work in the industry for as long as I recognised myself in the mirror in the morning; I hope I managed at least that.

Next time: Charles Payne gives his opinions on the rise of low-cost investing and presents his 11-point plan for transforming active management

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]]>http://www.evidenceinvestor.co.uk/charles-payne-lessons-learned-35-years-fund-industry/feed/06441What the sell-off means for investors: an interview with Lars Kroijer (1/3)http://www.evidenceinvestor.co.uk/sell-off-means-investors-interview-lars-kroijer-13/
http://www.evidenceinvestor.co.uk/sell-off-means-investors-interview-lars-kroijer-13/#respondMon, 12 Feb 2018 10:40:57 +0000http://www.evidenceinvestor.co.uk/?p=6411It’s been an eventful few days on the global stock markets. Of course, as every investor knows, volatility is part and parcel of investing in equities. Markets were just doing what markets do. Working out why they fell and where they’re likely heading next is all but impossible. But periods of volatility can be very […]

]]>It’s been an eventful few days on the global stock markets. Of course, as every investor knows, volatility is part and parcel of investing in equities. Markets were just doing what markets do. Working out why they fell and where they’re likely heading next is all but impossible. But periods of volatility can be very instructive, not least because they do get people thinking about the risk they’re taking. In this, the first part of a three-part interview, the investment author and former hedge fund manager Lars Kroijer gives his opinions on last week’s sell-off and what, if anything, investors should do in response.

Lars, what should investors bear in mind when prices are falling quickly? And what, if anything, should they do?

One thing that’s important, and I can’t say it enough, is this. Let’s say that markets trade at 100, and now they’ve fallen to 80. You still can’t beat the markets. The fact that markets fall that much may change your life, and your personal circumstances, in such a way that you should act. Maybe, all of a sudden, you should take less risk because you can afford less risk. But don’t think that you can beat the markets just because they’ve changed.

For investors who have a plan in place, and an asset allocation that matches their risk profile, it’s almost invariably best to do nothing. It can be hard, though, when people are making scary predictions. Should people switch the financial news off?

That wouldn’t be terrible advice. A lot of people can be experts on CNBC, Bloomberg and so on. I have been one myself, so that tells you something! Do you really think any of those people can predict the market? I think no. Even if they could, would you be able to identify which ones are right and which ones are wrong when they say such contradictory things? I say no. Are you entertained? Hopefully yes, but that’s a different issue. What do you get from that? I hope you get some idea about the risk of your portfolio. It should start you thinking if someone gets up there and says, I think the pound is going to collapse, or I think the S&P 500 is going to be down by 90%. By the way, you get to go on TV a lot more if you say really controversial things. It’s better entertainment, better ratings. Do think about that.

Ultimately you have to ask yourself how this will impact your risk. Don’t switch around a lot. Don’t change your mind every five minutes. In fact, the less you change your mind the better. If you’re thinking for the very long term, which is something I highly encourage, you will likely do better from lower transaction fees and by essentially ignoring the noise.

As usual, opinions on where markets are heading next are many and varied. Some say that last week was just a blip, others that it marks the start of a big bear market.

Markets are virtually impossible to predict. If you take the view that you know the markets are going to decline or the markets are going to go up, you’re essentially saying that you know something that the $100 trillion aggregate stock markets don’t know, which is an incredibly bold statement. I can certainly have the view that, relative to earnings, the markets have been trading expensively compared to what they’ve done historically. But that’s not the same as saying that, as a result of those higher prices, the markets are going to decline. I generally think you you should stay away from those sorts of bold statements. I don’t know anyone who’s been constantly right in making those predictions.

OK, so let’s say you weren’t prepared for what happened last week. What should you do to ensure that you can withstand the volatility we’re inevitably going to see in the future?

Let’s take a super simple world where you can either invest in equities or government bonds (which, by the way, I don’t think is a bad portfolio to be thing about). Everyone should decide, can I beat the markets or not? My argument is that the overwhelming number of people have no chance whatsoever of outperforming the financial markets. I often think of it as my mum versus the people I know from my time in the hedge fund industry, and it’s certainly not a fair match. My mum should never be in there, buying Facebook versus Google, or anything like that.

So, what should my mum do? If she wants equity exposure, she should buy the cheapest, broadest, most tax-efficient exposure to the equity markets that she can find. She needs to look for a product (and there are many index-tracking products that do this) that buys her the world in proportion to the market caps that the markets have ascribed to them. That’s equities done. That was easy!

Then you should combine that with something of little or no risk — perhaps a government bond that has roughly the same time horizons as you have for your investments. So it might be a five-, 10- or 20-year bond, or a number of them. Now you have two products. One is very high risk and the other is very low risk.

So, what next? My mum should think about her risk. Her risk is what determines how much she should own of each. If she is a very high-risk investor, she should buy a lot of equities, and if she is a very low-risk investor, she should buy a lot of government bonds. And if she’s in between, she should be somewhere in between. This is why it’s a hard question, because it depends on who you are and what your time horizon is.

If you look at the financial markets overall, there is a tremendous tendency to make all of that really, really complex, with lots of different products. There’s also this agenda to charge you a lot of money to sort through that myriad of opportunities. What I’m saying is that it doesn’t have to be that hard. You can create a very powerful portfolio, very cheaply and very simply. But that does not mean that you can predict which way the markets are going to go.

In your book, a key theme is the importance of diversification — not just across different asset classes, but also different geographical regions. Why are you so keen on a global approach?

Your risk is something that you should think continually about. In fact, it’s something that most people are guilty of not thinking enough about. And I think this is why a world equity index tracker is so sensible. If you think about the portfolio of most individuals, very often it’s their house, their education their job, their spouse. Those are all things that correlate highly in value. They’re all tremendously dependent on the local economy. So if you add to that concentration by buying local stock, that’s an unnecessary lack of diversification. You should absolutely diversify, and a global equity index tracker is the most diversified investment, in terms of equities, that you can possibly get your hands on.

That’s such a sensible and logical piece of advice. Why, then, is home bias — the tendency to overweight stocks from our country — so pervasive?

To a certain extent I think it’s historical. In the past it’s just been very expensive to trade abroad. Most people couldn’t just gain exposure to an Australian mining company, for example; it would take weeks, hundreds of years ago, to sail your gold down there. Now it’s instant. You can invest in crowd-funding campaigns around the world very cheaply, and with blockchain technology, currency exchanges are going to be much easier and cheaper going forward.

I think there’s a still a mindset that we should do stuff close to home. But you can’t diversify those things I mentioned — your house, your job, your future inheritance, your spouse’s career. All those assets are hard to diversify. Yet if you look at the portfolio of institutional investors in the UK, for instance, you might find that they hold 40 or 50% of it in UK stocks. Why is that? Very often there is no good answer.

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]]>http://www.evidenceinvestor.co.uk/sell-off-means-investors-interview-lars-kroijer-13/feed/06411Why did markets fall? Nobody knows and you shouldn’t carehttp://www.evidenceinvestor.co.uk/markets-fall-nobody-knows-shouldnt-care/
http://www.evidenceinvestor.co.uk/markets-fall-nobody-knows-shouldnt-care/#respondTue, 06 Feb 2018 13:40:08 +0000http://www.evidenceinvestor.co.uk/?p=6391No matter how many times you gently remind people that markets don’t carry on going up indefinitely, it always seems to comes as a shock when volatility suddenly strikes. And so it proved yesterday — Wall Street’s worst trading day in six years. There’s so much to say about these sorts of events, but nothing, frankly, that wise […]

]]>No matter how many times you gently remind people that markets don’t carry on going up indefinitely, it always seems to comes as a shock when volatility suddenly strikes. And so it proved yesterday — Wall Street’s worst trading day in six years.

There’s so much to say about these sorts of events, but nothing, frankly, that wise commentators haven’t said already. If I could point you to just one article about Monday’s events, it would be Jason Zweig‘s piece in the Wall Street Journal about the futility of seeking explanations for what caused the market sell-off, and the way the so-called experts are desperate to give the impression that they saw it coming:

“Market commentators are already arguing that stocks were bound to fall because interest rates are rising and inflation is sure to jump as the economy heats up. But a week or two ago, before stocks stumbled, analysts were saying just as glibly that moderate increases in interest rates and inflation were good for stocks.”

I’ve read other explanations for why the Dow Jones fell by 1200 points, and the S&P 500 by 4.1%, in a day. One fund manager, for instance, suggested the “unusual plunge” in the markets was probably “technically driven” by algorithm or quantitative trades.

It’s human nature to want an explanation for market falls, and for why our investments are worth less today than they were last week. We instinctively want to feel a sense of control. It’s why investors are so susceptible at times likes this to succumb to the temptation to act, or to be taken in by product providers for whom such episodes make perfect selling opportunities. But the truth is that nobody really knows why markets plummeted, or indeed what will happen next. And, for evidence-based investors, it really doesn’t matter.

I interviewed Gerard O’Reilly, the Co-CEO of Dimensional Fund Advisors, the other day and asked him what, if anything, investors should do in response to recent market highs, and his answers seem especially relevant today. The first thing to remember, he said, is that volatility is inevitable:

“You have to acknowledge that if you’re going to invest in stocks, there’s going to be volatility associated with the value of your investment. Accept that from the beginning, because it is going to happen. We will have negative returns in the future; we will have positive returns in the future.”

So, does that mean that, because markets have been on a long bull run, and because they fell so far yesterday, that we’re now entering a bear market? No, it doesn’t. We may be, of course, but the risk of that happening is already baked into prices.

“The question you have to ask yourself is, at any point in time, do you think that investors, in aggregate, set prices to a level such that the expected return is negative? No. Investors don’t sign up for a negative expected return when they’re putting the value of their assets at risk.”

Finally, what should investors do now?

“Set an asset allocation that you can live with, that has a good balance between stocks and bonds, so that you can ride out those tough times, and then stop worrying.”

That’s right, stop worrying. Markets will do what markets will do. Life’s too short topay them too much attention.

Are you an evidence-based financial adviser?

The Evidence-Based Investor is produced by Regis Media, a boutique provider of high-quality content and social media management for evidence-based advice firms. For more information about what we do, visit our website or YouTube channel.

]]>http://www.evidenceinvestor.co.uk/markets-fall-nobody-knows-shouldnt-care/feed/06391Gerard O’Reilly: How investors should view today’s markets (2/2)http://www.evidenceinvestor.co.uk/gerard-oreilly-investors-view-todays-markets-22/
http://www.evidenceinvestor.co.uk/gerard-oreilly-investors-view-todays-markets-22/#respondMon, 05 Feb 2018 12:52:53 +0000http://www.evidenceinvestor.co.uk/?p=6382There’s been a big response to Part 1 of my interview with Dr Gerard O’Reilly, the new Co-CEO of Dimensional Fund Advisors. In it he explained how everything Dimensional does is underpinned by empirical research, and how tilting towards size, value and profitability premiums should, over time, deliver market-beating returns. The problem, of course, is […]

]]>There’s been a big response to Part 1 of my interview with Dr Gerard O’Reilly, the new Co-CEO of Dimensional Fund Advisors. In it he explained how everything Dimensional does is underpinned by empirical research, and how tilting towards size, value and profitability premiums should, over time, deliver market-beating returns.

The problem, of course, is that you can know your Fama-French inside out, but if investors don’t know themselves, and particularly their ability to deal with their emotions in falling markets, they risk having a bad investment experience.

In Part 2 of the interview, Dr O’Reilly explains the need for patience and discipline, and also the importance of global diversification. He gives his opinion, too, on how investors should view recent stock market highs. Finally, he explains why Dimensional, as a company, puts so much emphasis on the value of financial advice.

RP: Fama and French have identified a number of risk factors that tend to deliver higher returns over time. The ones Dimensional focuses on are size, value and profitability. To what extent should investors diversify across those different factors?

GO’R: I would say a good approach is a globally diversified portfolio to begin with. Global diversification is your friend in equities and it’s your friend in bonds. Now, that doesn’t mean that global diversification won’t result in some periods where you have disappointing returns, or negative returns; that’s not what global diversification does for you. But it does improve the reliability of your ability to pursue factor premiums. So, start with a globally diversified portfolio, then overweight smaller cap stocks, lower relative price, or value, stocks, and higher profitability stocks, in a measured way. You should have all three in one portfolio.

There will be years when small caps underperform large, or value underperforms growth, or high profitability underperforms low profitability. There will be some of those years. But by having a well-diversified portfolio that pursues all of those premiums, you smooth out those years a little bit. While there will still be the possibility of underperformance, you improve the possibility of outperformance.

The other thing I would mention is the time horizon. While such a portfolio has positive expected outperformance every day, what’s expected doesn’t always happen. But the probability of what’s expected happening increases the longer the holding period. That’s what you see if you extend the holding period to ten years or 20 years — the possibility of negative size, value or profitability premiums decreases dramatically. So for folks with long horizons, the probability of them realising those premiums goes up.

RP: But is there a danger that, as more and more tilt towards these factors, the premiums associated with them will eventually disappear?

GO’R: To address that question you have to ask, is there a danger that people demand the same expected return to hold every stock in the world? If the answer to that question is Yes, and there’s no difference in expected returns across stocks, there’ll be no premiums of any kind. I think the probability of that happening is small. People demand differences in expected returns to hold different securities for lots of different reasons. Differences in perceived risk may be one of those reasons. But I think it’s a highly unlikely state of the world where, with every stock, no matter what the stock, investors are willing to hold each and every one of those at exactly the same rate of return.

As soon as you have differences in expected returns, that’s a discount rate effect, and you’ve got value and profitability premiums. What’s value telling you? People are willing to pay a lower price for this stock and a higher price for that stock. Low price, high discount rate. Profitability? This stock has higher expected cash flows than that stock. High profitability versus low profitability. If the price is the same, there’s a higher discount rate. As soon as you acknowledge that there can be differences in expected returns across stocks, it implies you have premiums.

Now, the question becomes, what’s the expected magnitude of those premiums? Could they decrease over time? That’s a possibility, though it’s something that’s difficult to measure one way or the other. They can get bigger or smaller for lots of different reasons. The way that we at Dimensional think about it is that if you take a measured approach, so that you still remain globally diversified, with thousands of stocks in your portfolio, even if the premiums are smaller or bigger (and you don’t know what they’re going to be in the future), you’ll end up with a good investment solution.

One last point I would make is this. Imagine everyone wants to become a value investor. What happens to value stocks? They become growth stocks. What happens to growth stocks? They become value. The market has to be held by everybody, and if everybody loves value, you should expect a strong premium from value, while all the value stocks move to growth and all the growth stocks move to value. So, even from a conceptual perspective, you’ve got to think about it at the stock level and how those premiums are realised over time.

RP: Stock markets have had been on a good run for many years now. How, if at all, should that affect the way that investors approach the markets at the moment?

GO’R: The first thing you need to recognise when you’re going to invest in the stock market is there will be periods of positive returns in the future, and there will be periods of negative returns. When those will occur, that’s unpredictable. You can’t say when the returns will be positive or when they will be negative. But you have to acknowledge that if you’re going to invest in stocks, there’s going to be volatility associated with the value of your investment. Accept that from the beginning, because it is going to happen. We will have negative returns in the future; we will have positive returns in the future.

Now the question you have to ask yourself is, at any point in time, do you think that investors, in aggregate, set prices to a level such that the expected return is negative? No. Investors don’t sign up for a negative expected return when they’re putting the value of their assets at risk. When they invest in stocks there’s uncertainty about what their future wealth will be. They demand compensation to bear that uncertainty. So prices are set to such a level that the expected equity premium is positive.

If what’s expected comes to pass, you get positive returns. But will something worse than is currently expected today come to pass? Well, I don’t know! What’s expected today, and all the information that’s aggregated across market participants around the world, is in the price today. So if something unexpected happens in the future, yes, we could have negative returns if it’s unexpectedly bad; if it’s unexpectedly good, we could have even more positive returns.

What you have to acknowledge is that, when you invest in stocks, there’s going to be volatility. There’s going to be tough times and good times. Set an asset allocation that you can live with, that has a good balance between stocks and bonds, so that you can ride out those tough times and stay disciplined, and then stop worrying. Markets are good at pricing information. They’re good at setting themselves up to have positive expected returns. But things that are unexpected always happen. And that causes markets to go up and go down.

RP: Dimensional positively encourages investors to use a financial adviser. Why is that?

GO’R: There’s a rich field of academic finance that has been developed over 50 or 60-plus years. It’s complex, it’s deep and it takes a lot of expertise to understand. It’s just like medicine. Why do you have a medical doctor? Because they have expertise. They’ve dedicated their lives to understanding something that most people haven’t dedicated their lives to understanding, and they can provide you valuable services that can give you a better experience, because they’re keeping abreast of all that medical research and all those advances in medicine. It’s the same thing when it comes to financial advice. With any field, there are going to be experts who can help people have a better experience, and that’s true when it comes to investing.

Something that is very important when it comes to investing is discipline, and financial advisers can help to instil that discipline in investors, so that they stay the course. As I said, returns are going to be strong and they’re going to be disappointing. You’ve got to get used to that right up front when you invest in markets. It’s important, if you can have a long time horizon, that you increase the probability of realising positive returns in all the various asset classes that you can invest in. A financial adviser can help explain what all those different asset classes are, how they come together, and then, when returns are disappointing, help keep the investor focused and disciplined.

There are other aspects to having a financial adviser too. I have a financial adviser who can help me with tax planning, estate planning and all the different types of wealth planning that most people don’t spend a lot of time gaining the expertise to be really good at. Some do, but not everybody does. So you can really have a better overall experience across all aspects of your financial health through working with an adviser.

Are you a financial adviser who shares Dimensional’s evidence-based approach to investing? Then why not subscribe to regular, high-quality video content, customised for your firm, that’s designed to help you attract, retain and educate clients? You’ll find details and prices on the Regis Media website and explanatory videos on our YouTube channel.

For financial advisers who want to educate their clients and prospects about evidence-based investing, this video subscription from Regis Media is an efficient, value-for-money solution

]]>http://www.evidenceinvestor.co.uk/gerard-oreilly-investors-view-todays-markets-22/feed/06382The Dimensional approach: an interview with Gerard O’Reilly (1/2)http://www.evidenceinvestor.co.uk/dimensional-approach-gerard-oreilly-12/
http://www.evidenceinvestor.co.uk/dimensional-approach-gerard-oreilly-12/#respondWed, 31 Jan 2018 18:35:35 +0000http://www.evidenceinvestor.co.uk/?p=6365One of the best things about this job is getting to meet some of the smartest people in the world of finance, and they don’t come much smarter than Dr Gerard O’Reilly. After earning a doctorate in Aeronautics and Applied Mathematics from the California Institute of Technology, he joined Dimensional Fund Advisors as a Research […]

]]>One of the best things about this job is getting to meet some of the smartest people in the world of finance, and they don’t come much smarter than Dr Gerard O’Reilly.

After earning a doctorate in Aeronautics and Applied Mathematics from the California Institute of Technology, he joined Dimensional Fund Advisors as a Research Associate in 2004 and became Co-CIO ten years later. Last year he was appointed as Co-CEO, along with Dave Butler.

I recently caught up with Dr O’Reilly at Dimensional’s London offices, where he gave me a rare and wide-ranging interview. I’m running the interview in two parts. This is Part 1, in which he sets out Dimensional’s approach to investing; I’ll post Part 2 next week.

RP: Dimensional’s philosophy is very much based on academic evidence. Briefly, what sort of evidence are we talking about? And why is it so valuable?

GO’R: Academic finance is a discipline with a long and rich history. It’s been around for 50 to 60-plus years, and we at Dimensional have been involved with a lot of the great minds of academia over the past number of decades. What academics have really tried to do is understand the function of markets, how markets work, what drives prices, and what information you can get out of prices for publicly traded securities, and they’ve gone about answering those questions in a very theoretical, robust and empirically-driven way. So we can really address these questions with as many scientific methods as possible.

RP: What would you say to people who argue that academic finance is theoretical, but that financial markets are about the real world?

GO’R: I would agree. Academic evidence has to be, in some respects, theoretical. Academics come with models of the world, and those models are usually incomplete. But you gain insights about the real world from those models — insights about better ways to invest, better ways to structure portfolios — so that when you come to the real world you’re better equipped to make rational investment decisions. Academia, by its nature, has to simplify the real world, so that you can understand the real world better. But that’s the beauty of it. Academics simplify the world just enough so that it’s real enough to be interesting, but understandable enough that you learn something.

For Dimensional, I would say that pretty much everything we do has a theoretical and empirical foundation — for example, in terms of how we structure portfolios, how we identify differences in expected returns, and how we go about managing those portfolios from day to day. A lot of that is based on academic finance, but we couple that with very practical experience, because you have to interact with markets, you have to understand regulation and the various frictions in markets. I think Dimensional does a great job of pairing those academic insights with a very structured way of investing, and a lot of knowhow on how to execute efficiently in real markets.

RP: For you, who are the most important academics you work with?

GO’R: There are a number of absolutely outstanding names in academic finance we work with. I won’t name them all but I’ll mention a few. Gene Fama, who won the Nobel Prize a few years ago, is an academic that we have been very closely related to since the founding of the firm, along with Ken French, who is a co-author and a very close collaborator with Gene Fama. What we’ve used from their work is the intuition that it’s given us about prices. Security prices reflect information, and in particular we think that different stocks have different expected returns, and different bonds have different expected returns. French and Fama’s work has helped us tremendously in using real-time security prices to say which assets have higher expected returns and which have lower expected returns.

Other academics we’ve worked with are Robert Merton and Myron Scholes, both of whom have also won a Nobel Prize. Their work has also given us tremendous insights, whether it’s in life-cycle finance, or how to structure portfolios.

So that’s to name just a few of what I call the greatest academics in finance, and there are many more that we’re associated with and work with. The work that they have done has really led to some big innovations in the field of practical investing that Dimensional has been able to use to the benefit of our clients.

RP: It’s more than 25 years since French and Fama produced their famous Three-Factor Model. Tell me how Dimensional’s research process works today.

GO’R: We look at up-to-the minute research, and how we approach research is like this. We need to have a good rationale to expect something in the data. How do academics answer problems? They pose the problem, they set up a model to help study the problem, they get empirical data to test the model, and then they determine if the data rejects the model. If the data does not, they may have a good working hypothesis that allows them to learn something about the problem they posed. That’s the scientific process we use.

When it comes to differences in expected returns, what the Three-Factor Model did was it helped organise the historical data to show systematic ways to pick up differences in expected returns across stocks. So, should you use a new model every year? Well, there are some things that stay the same, and some things that change. So Dimensional changes where we need to change, and where we don’t need to, we don’t.

We think there are differences in expected returns across stocks and across bonds. How do you identify those? Well, what’s the intuition from the Three- and Five-Factor Model? Lower prices and higher expected cash flows mean higher expected returns. So, how do we structure portfolios? We say, let’s look for low-price stocks, relative to some fundamental measure. Then, high expected cash flows — i.e. high profitability — mean higher expected returns, so let’s overweight those stocks.

We don’t think investors are suddenly going to stop demanding differences in expected returns. We think it’s very unlikely that every stock in the world will have the same expected return at some point in the future. Unless that happens, you’re always going to have size, value and profitability premiums.

But what changes is how you go about identifying which stocks have low relative prices, and how you go about identifying which have high expected cash flows. Those things evolve as accounting practices evolve, as data evolves, and as you get better and better data. But the underlying principle of the Three- and Five-Factor Model has been around for hundreds of years and will be around for hundreds of years.

RP: As you say, Dimensional’s focus is on delivering higher expect returns through exposure to specific risk factors. But as Fama has himself said, the broad, market-cap-weighted index is still an excellent starting-point, isn’t it?

GO’R: I would agree with Gene 100%. If you are investing in an entire market in a cap-weighted portfolio, that’s a pretty good investment. There’s nothing wrong with that investment.

What do investors do? Investors save, so they forgo consumption today, to grow their wealth, in excess of inflation, so they can consume more tomorrow. That’s why most people save. They save for retirement or for consumption in the future. If you can increase the expected return of a portfolio, there are two things you can do with that. You can lower the amount that they have to save today, to afford a similar level of consumption in the future. Or you can have them afford more in the future, so they can live an even better life in the future, from making sacrifices today.

When it comes to increasing expected returns, you want to do so in a very careful way. Because the market is a very good portfolio to own, as you go about increasing expected returns by pursuing size, value and profitability premiums, you don’t want to end up with a portfolio that’s inferior to the market, that’s a lot less diversified, that has much higher turnover, or that has much higher costs. And what we’ve been able to do at Dimensional is pursue those premiums in a very diversified, cost-efficient, low-turnover way, so that people can expect to consume more in the future by investing in funds that pursue these premiums than they would by just investing in the market. That’s really what we’re about. We’re enabling people to retire either earlier or with a better standard of living in retirement, and I would say that’s the main reason for anyone to pursue higher expected returns.

RP: If people do go down the factor investing route, should they be looking to capture one particular risk premium, or a combination of them? And how many is too many?

GO’R: That’s a great question. You really have to examine what each new variable brings to the table. Does it improve your understanding of expected returns and, in particular, differences in expected returns across stocks? And does that enhanced understanding allow you to build a better portfolio? That should be considered case by case.

So, as an example, Dimensional started off with small-cap portfolios back in the early ‘80s, and added value in the ‘90s, and then in the 2000s we added profitability. Each one of these enhanced our understanding of what drives differences in expected returns, and enabled us to build portfolios that were still diversified but that were better and more reliable, as you added a new premium.

Ultimately, the more premiums you pursue, the marginal impact they’re going to have on the portfolio is going to diminish. It’s all about expected cash flows and differences in prices. That’s the motivation for all those premiums. Then, for us, the question is, how can I say something more precisely about the expected cashflows, or differences in prices? That’s where the evolution comes along.

If you’re into 30 or 40 or 50 factors, they’re all interacting with each other, and it’s not clear what you’re getting in that sort of portfolio. As few as possible to describe the world well is Dimensional’s preferred position.

In Part 2 of this interview, I’ll be asking Gerard O’Reilly:

Why is patience so important for investors, and factor investors in particular?

What, if anything, should investors be doing in response to recent all-time market highs?

Finally, should investors use a financial adviser? And how does an adviser add value?

Gerard O’Reilly, on the right, with Robin Powell and Regis Media’s Christina Waider

]]>http://www.evidenceinvestor.co.uk/dimensional-approach-gerard-oreilly-12/feed/06365Over to you, Chris Cummingshttp://www.evidenceinvestor.co.uk/over-to-you-chris-cummings/
http://www.evidenceinvestor.co.uk/over-to-you-chris-cummings/#respondFri, 26 Jan 2018 12:44:05 +0000http://www.evidenceinvestor.co.uk/?p=6356If you didn’t listen to In Business on BBC Radio 4 last night, you really should catch up with it. The programme’s called The Transparency Detectives, and it’s available for download via the In Business podcast page. Lesley Curwen and her team should be congratulated on a thorough investigation of the issues around investment fees and charges, […]

]]>If you didn’t listen to In Business on BBC Radio 4 last night, you really should catch up with it. The programme’s called The Transparency Detectives, and it’s available for download via the In Business podcast page. Lesley Curwen and her team should be congratulated on a thorough investigation of the issues around investment fees and charges, and the continuing lack of transparency from the UK asset management industry.

During the programme, Curwen asks Chris Cummings, Chief Executive of the fund industry trade body, the Investment Association, whether he regretted the language used in its infamous “Loch Ness Monster” report from August 2016. The report claimed there was “zero evidence that funds’ returns are affected by hidden fees lurking within, suggesting that ‘hidden fund fees’ may in reality be the ‘Loch Ness Monster of investments’”. Cummings wouldn’t give a straight answer; by way of an excuse, he said the report was published before he took up his position. Although that’s true, it does remain on the IA’s website, available for everyone to read, despite the fact it is now patently clear that it is completely misleading.

Andy Agathangelou, the Chairman of the Transparency Task Force of which I’m an official Ambassador, has now written an open letter to Mr Cummings, asking him to take the report down and apologise for it.

Like Andrew, I found the Loch Ness Monster report offensive to everyone who’s worked so hard at drawing this issue to the public’s attention. All of us on the Task Force are volunteers. We don’t get paid for the work we do; we do it because we believe in it. For the Investment Association to suggest, effectively, that we’ve made this whole thing up when we clearly haven’t is deeply insulting.

Here is Andy’s letter in full. It demands a response. Over to you, Mr Cummings.

Dear Chris,

I trust you are well.

I have listened the BBC Radio 4 programme that was aired on 25th January about hidden fees in investments and I am connecting with you today in light of your comment on the programme, in response to a question by Lesley Curwen, that the language used by the Investment Association in its August 2016 ‘Loch Ness Monster’ press release was “regrettable.”

In that press release, referencing a research report that was widely criticized, and which I believe the Investment Association commissioned itself, the Investment Association stated: ‘The report finds zero evidence that funds’ returns are affected by hidden fees lurking within, suggesting that ‘hidden fund fees’ may in reality be the ‘Loch Ness Monster of investments’.

Despite its inaccuracy and its offensiveness the press release can still be read on your website, here.

Furthermore, via your Director of Public Policy, Jonathan Lipkin, I asked the Investment Association to apologise to campaigners for having issued such an offensive press release. The Investment Association considered doing so but to my surprise chose not to. I wasn’t impressed with the misleading and offensive press release and I was even less impressed by your organisation’s unwillingness to act courteously and apologise for the offence caused.

As you know, some campaigners such as Gina Miller and Dr. Chris Sier have been working tirelessly and selflessly to educate your organization on the hidden fees issue for as much as ten years, using their own personal time and resources to do so, for no reward whatsoever. I believe that they and people like them deserve an apology from the Investment Association and to be honest I think Gina Miller, Dr. Chris Sier et al should also be given public recognition and thanks by the Investment Association and perhaps even Her Majesty’s Government for their dogged determination to have investors’ interests looked after properly. Pensioners in years to come will be able to enjoy a better standard of living because of the thankless work that they and many others have been doing.

In light of the admission you made in yesterday’s programme and in light of the fact that MiFID II has now completely disproven the assertion that there is no evidence of hidden fees (please see this analysis from the lang cat, on page 12) I believe that now is the right time for the Investment Association to take action and admit that it has been completely wrong about hidden fees for a long, long time.

I therefore hereby respectfully and courteously ask that you, as Chief Executive of the Investment Association take the following action:

Please take down the misleading and offensive August 2016 press release from your website

Please issue a communication piece clearly stating that the Investment Association’s position that there have not been any hidden fees for all these years has in fact now been proven to have been entirely wrong

Please issue a public apology about your “Loch Ness Monster” press release to Gina Miller, Dr. Chris Sier and all others that have been campaigning for greater transparency on costs and charges

Please give public recognition and thanks for the service to the nation that Gina Miller, Dr. Chris Sier and others have selflessly provided over the years. I can provide you with a long list of names, over 100 people in fact. In my opinion they have been doing the Investment Association’s job of reforming the Asset Management Industry and helping ensure investors get better value for money for you

Please ensure that none of your members treat pro-transparency campaigners disrespectfully and discourteously; and most definitely please ensure that none of your members’ employees ever resort to the kind of bullying and emotional blackmailing mentioned by Gina Miller in yesterday’s programme

Please introduce enforceable codes of conduct for all your members that insist on the highest standard of professional conduct; including properly looking after the interests of the investor

There is a close correlation between transparency, truthfulness and trustworthiness. The sad truth is that The Asset Management industry is not trusted and I believe that the lack of trust in your industry is a significant factor in the UK having the lowest savings ratio it has had since 1963. We all need to work together to rebuild trust and confidence in the pensions and investments market; not doing so will be leaving a systemic risk unchecked. Nobody wants millions of people unable to afford a financially secure retirement; and the worst case scenario of that risk is extremely severe – the inter-generational tensions it may create are potentially destabilizing at a societal and at an economic level. Please do all you possibly can to exert your leadership on your membership such that all your members operate as transparently as possible; because only through transparency do we have any hope of rebuilding trust.

I am happy to discuss these requests with yourself and the Financial Conduct Authority with a view to concluding the whole matter expediently; and I am happy to be joined by all other pro-transparency campaigners that may wish to attend.

I believe that a cultural transfusion within the sector is now needed and that’s going to take a great deal of envisioned leadership from all interested parties. I am happy to do all I can to support any authentic efforts you and others make in reforming the sector.

If you, personally; the Investment Association as a whole and all your members are authentically aligned with wanting the best possible outcomes for the UK’s investors and pension savers we are on the same side. If that’s the case let’s all work together, collaboratively and collegiately with a renewed sense of purpose about what the asset management industry should be about – serving the needs of its clients to the best of its ability.

]]>http://www.evidenceinvestor.co.uk/over-to-you-chris-cummings/feed/06356Fee reductions mean nothing when you can index for 1/12th of the costhttp://www.evidenceinvestor.co.uk/fee-reductions-mean-nothing-index-12th-cost/
http://www.evidenceinvestor.co.uk/fee-reductions-mean-nothing-index-12th-cost/#respondTue, 23 Jan 2018 12:22:54 +0000http://www.evidenceinvestor.co.uk/?p=6349A new, long-form interview with Jack Bogle has just gone online, and, like all Bogle interviews, it’s worth reading. The interview was conducted by Lawrence Siegel, who is is the Gary P. Brinson director of research at the CFA Institute Research Foundation, a senior adviser to OCP Capital LLC, and an independent consultant, writer, and […]

The interview was conducted by Lawrence Siegel, who is is the Gary P. Brinson director of research at the CFA Institute Research Foundation, a senior adviser to OCP Capital LLC, and an independent consultant, writer, and speaker, specialising in investment management.

The interview is published on the Advisor Perspectives website, and you’ll find a link to it below. But here are the highlights.

Index funds are still 12 times cheaper than active

“Let’s say an index fund can operate at 4 basis points and you’ve got somebody like Fidelity operating at, say, 70 basis points. If Fidelity cut its expenses from 70 to 50, that would have a staggering impact on the firm’s operations. It would eliminate their profits. It would be a mess, for the want of a better word. Yet even that lower cost would still be 12 times as high as the going rate for index funds. There’s really not much point in shaving prices in the world of active management.”

The odds of an active investor outperforming long term are about 0%

“With the counter-productivity of swapping from one expensive fund to another the odds are about 0% that an average investor can outpace the stock market over that long a time period. People are going to tell you there’s a certain chance, a 1% chance or a 2% chance. That’s the chance that a given fund will beat the market, not a given investor. I don’t happen to think even that’s right.”

One of the biggest challenges for investors is the temptation to “do something”

“The temptation to “do something” is one of the worst temptations that investors face. There is always some bluebird on the horizon. Maybe it’s bitcoin or some other kind of coin. These things come and go. In an investor’s lifetime he’s going to be so much better off owning the total stock market and never trading it.”

The ETF industry is largely for active investors using passive funds

“Passive management with passive investors is what I would do. The ETF business, in contrast, is passive management (sort of) with active investors. There, the activity returns, the trading costs return, and the emotions return. By chasing performance, investor returns go down. The traditional route will be the winning route in the long run.”

Fees collected by active management have soared in line with the stock market

“Active managers run a pretty vibrant business when you realize that, in the last 10 years, assets of active managers have gone from $7.3 trillion to $11.4 trillion. That’s about a 60% gain. Since there is not much net new money coming in, almost all of that gain comes from market appreciation. They are sitting on very profitable businesses, and I don’t think they yet feel the pressure to make changes or make some kind of strategic adjustments.”

CEO pay is a moral and social outrage

“Executive compensation has gotten totally out of hand. Compensation consultants have introduced a process of “ratchet, ratchet and bingo,” to use Warren Buffett’s felicitous phrase. Nobody wants their CEO to be in the fourth quartile of compensation, so they bump them up to the first or second. It is an outrage — a moral outrage, a social outrage.”

]]>http://www.evidenceinvestor.co.uk/fee-reductions-mean-nothing-index-12th-cost/feed/06349Revealed at last — the true cost of investing in UK fundshttp://www.evidenceinvestor.co.uk/revealed-last-true-cost-investing/
http://www.evidenceinvestor.co.uk/revealed-last-true-cost-investing/#respondMon, 22 Jan 2018 16:00:07 +0000http://www.evidenceinvestor.co.uk/?p=6345It’s been a long time coming. But, after years of campaigning by my colleagues at the Transparency Task Force, by Gina and Alan Miller’s True and Fair Campaign and, of course, by The Evidence-Based Investor, UK consumers are finally being told the true cost of investing. MiFID II, the European Union directive which came into […]

]]>It’s been a long time coming. But, after years of campaigning by my colleagues at the Transparency Task Force, by Gina and Alan Miller’s True and Fair Campaign and, of course, by The Evidence-Based Investor, UK consumers are finally being told the true cost of investing.

MiFID II, the European Union directive which came into force earlier this month, requires asset managers to disclose to investors all the fees and charges they pay. Hitherto, the big fund managers have talked about the annual management charge (AMC) as if that were all that investors pay. In fact, as TEBI readers know, those figures tell only part of the story. When you factor in all the other costs involved — particularly transaction costs — investors are paying far more than most of them ever realised.

Analysis just released by the Edinburgh-based asset management consultancy, The Lang Cat, shows that once transaction costs are included many investors pay almost double the ongoing charge figure (OCF) in the UK’s most popular funds. This can go up to four times the OCF, if you include platform charges and performance fees.

By way of example, the Janus Henderson UK Absolute Return fund has an OCF of 1.06%, and transaction costs of 0.79%. If platform fees and a performance fee are charged, the total cost of investing jumps to an average of 3.82%. In other words, investors in that fund need it to outperform the market by 382 basis points a year just to cover their costs. That’s a huge hurdle for any fund manager to overcome.

Even Vanguard, which has done more than any other company to drive costs down, has admitted that some of its funds double in price when transaction costs are levied, and quadruple once its platform fee is also factored in.

For me, there’s a strangely bittersweet feeling at seeing these figures finally revealed in black and white. To quote Vanguard’s Nick Blake in the FT, “if this disclosure can help clients get more accurate numbers and make it easier for them to make investment decisions, that can only be a good thing.”

But there are several reasons why UK investors should feel justifiably angry about all this. Why, for example, have we had had to wait quite so long just to find out how much we pay?

Some media outlets are covering this story as if these fees and charges have come as a shock. The truth is that asset managers have been getting away with smoke and mirrors for decades. If more journalists — and for that matter, financial advisers and other investment professionals — had asked more searching questions over the last 30 years, the average UK investor would be in a far better position today than they actually are.

Consumers should also feel let down by successive UK regulators. The lack of transparency around asset management costs has been known for many years. Why then, has it taken a European Union directive to force the industry to do the decent thing?

The Lang Cat’s Mike Barrett sums it up when he says: “It is undoubtedly good that this clarity is here now. But it is grimy that it has taken some EU regulation for asset managers to tell investors what the true cost of investing is. You have always been paying these fees, but now the fund groups have the good grace to tell you these costs upfront.”

But it gets worse. For years the industry has denied there was an issue at all. 18 months ago, for instance, the Investment Association, the UK trade body for asset managers, released a study claiming there was “zero evidence” of hidden fees and charges.

Even now, we’re told, several major fund houses and product distributors are refusing to co-operate fully with the new regulations. The FT, for example, has named Aegon, Fidelity, Aviva and Axa as examples of firms that have failed to provide the newspaper with the relevant information.

So, what happens now? I have two predictions. The first is that the fund industry will continue to drag its feet as much as it can — delaying full disclosure until it’s simply no longer able to resist. My second prediction is that, as and when other fund managers gradually start to disclose the true cost of investing in their products, we’re going to see some truly shocking revelations.

As a late-twentieth-century US President may have put it, if you thought these latest figures looked bad, you an’t see nothin’ yet.

]]>http://www.evidenceinvestor.co.uk/revealed-last-true-cost-investing/feed/06345Short-term bias is putting Britons at serious financial risk — reporthttp://www.evidenceinvestor.co.uk/if-only-we-could-learn-to-wait/
http://www.evidenceinvestor.co.uk/if-only-we-could-learn-to-wait/#respondFri, 19 Jan 2018 16:08:11 +0000http://www.evidenceinvestor.co.uk/?p=6337“Waiting helps you as an investor,” Charlie Munger once said, “and a lot of people just can’t stand to wait. If you didn’t get the deferred-gratification gene, you’ve got to work very hard to overcome that.” Unfortunately, it seems, very few of us were born with that particular gene, and perhaps there’s something about the […]

]]>“Waiting helps you as an investor,” Charlie Munger once said, “and a lot of people just can’t stand to wait. If you didn’t get the deferred-gratification gene, you’ve got to work very hard to overcome that.”

Unfortunately, it seems, very few of us were born with that particular gene, and perhaps there’s something about the way we live now that makes it even harder for us to put up with a little short-term pain for the sake of long-term gain.

New research by the digital wealth manager MoneyFarm paints a pretty grim picture of our addiction to short-term thinking. For its report, MoneyFarm Decodes Short-Termism, the company interviewed more than 1,000 adults across the United Kingdom. These were its main findings:

— 63% of people agreed they “live only for the moment”;

— 70% of people said they had no plans in place for retirement;

— 77% admitted they didn’t look more than five years ahead;

— 31% said they didn’t plan more than six months in advance; and

— one in five people said they had no long-term plans at all, whether, health-wise, career-wise or financially.

Interestingly, 39% of women said they were not financially prepared, compared with 26% of men.

Asked to explain their failure to plan, 42% of people blamed everyday responsibilities, 22% put it down to a tendency to spend now rather than save for later, while 17% said they were simply distracted.

Jonathan Openshaw, an expert in future trends and one of a panel of experts quoted in the report, believes another major contributor is that people have too much choice as to how to spend their time and money.

“With a surfeit of choice,” he says, “comes a paralysis of action. Because you have so much information, it is hard to know how to act effectively. We need to reposition how we approach long-term challenges and we need to start seeing them as opportunities rather than threats.”

“The majority of Britons are taking an extremely high risk approach to future planning. They are sleepwalking their way into an uncertain financial future, exhibiting very little proactivity when it comes to money matters in particular.”

Professor Ivo Vlaev, a behavioural scientist from the University of Warwick, said that we are “in danger of creating a nation addicted to the quick-fix of instant gratification at the expense of important, basic long-term life goals, such as health, wellbeing and financial security”.

Whatever the reasons for this present bias — our tendency to overvalue immediate awards at the expense of long-term outcomes — it is clearly is a problem. Well done to MoneyFarm for helping to stimulate debate on such an important issue.